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Investing in Biofuels: Ethanol Will Do More Than Survive

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Corn-based ethanol was America's silver bullet in the alternative-fuel camp when oil first soared past $100 a barrel, but it's future holds challenges for many of its players.

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Ethanol has been a fuel for automobiles from the start of the industry. In 1896, Henry Ford built his first car, the Quadricycle, to run on ethanol.

His Model T, which revolutionized auto manufacturing when it rolled off the assembly line in 1908, was designed to run on ethanol or gasoline. Even as Ford continued to push for ethanol from corn as the logical fuel, lower priced gasoline won out.

Ethanol made a big run again recently, but when corn prices shot up, people started questioning whether corn's best use was for fuel. No doubt there was a place for ethanol subsidies at one point, but I think it's foolish to pay billions of dollars to support a fully developed industry when we're suffering from a fiscal crisis.

There are many arguable downsides to ethanol supports. Not least is the effect on rising food prices (although other factors like an awful world crop year last year and booming Asian demand for cattle feed are also significant in corn's price rise too).

Surprisingly, it seems Congress, long the defender of ethanol, is prepping to end the subsidies. Maybe.

In June, various reports indicated that Congress had reached a bipartisan deal to eliminate the subsidies in July, in a bid to narrow the current deficit by a billion or two. True to form, Congress didn't end up actually doing anything on the deal, opting to go on August vacation instead.

But ethanol industry players expect that Congress will let the subsidies and tariffs expire as scheduled at year's end. There's good reason to: Under rising ethanol-blending mandates, it is estimated the subsidies as structured will cost taxpayers $54 billion through 2015.

Don't bet on it just yet-there was a lot of expectation that Congress would let the subsidies expire last year too.

Setting subsidies aside, there is a strong argument to be made that ethanol's inclusion in the fuel mix lowers US gasoline demand and therefore gasoline prices. A 2008 University of Iowa study estimated ethanol kept gas prices 20 cents a gallon lower (or more) by lowering gas demand.

Removing the tariffs on imported ethanol should also lower ethanol prices and allow cropland to be used for food-not fuel-easing global food prices in turn. A federal study last year found a net savings in carbon impact versus gasoline (albeit relatively small), which in turn has environmental benefits.

Of course, the uncertainty of subsidies places a big question mark before those looking to invest in the biofuels industry.

Somewhat surprisingly, the major ethanol refiners in the US, Archer Daniels Midland (ADM), Valero (VLO) and The Andersons (ANDE) haven't suffered much. ADM and The Andersons have actually performed slightly better than the broad market since June (both have notable non-ethanol business lines benefiting from corn's price strength).

Meanwhile Valero, which is a significant gasoline refiner, has been weaker than the market of late because gasoline refinery maintenance has taken some capacity off line this month.

While each would take a hit from the elimination of ethanol-refining subsidies, they still have the financial heft to stay afloat and meet the growing ethanol-blending mandates that don't appear to be going away. Earlier this year, the Environmental Protection Agency approved using a 15% ethanol blend in gasoline for cars made in 2001 or after.
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